Why Valuing Internet Start-Ups Is So Hard

Google's Groupon bid and Twitter's valuation raise questions about how the tech industry estimates worth

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Whether it's Google extending a $6 billion bid to the deal-of-the-day site Groupon or Kleiner Perkins, a venture capital firm, valuing the social-networking sensation Twitter at nearly $4 billion, the estimated worth of tech companies has stirred controversy and dominated headlines in recent months. Why is value so hard to pin down online?

  • History of Internet Is Series of Opportunities Missed, states James Surowiecki at The New Yorker. Now it appears that history's lessons have "been learned too well," he adds--companies feel they have to jump on every possible opportunity:
The major record labels let Apple take over the digital-music business; Blockbuster refused to buy Netflix for a mere fifty million dollars; Excite turned down the chance to acquire Google for less than a million dollars. Time and again, businesses with seemingly dicey prospects have ended up becoming huge successes, and price tags that once seemed absurd have turned out to be bargains. But big companies have learned their lesson: these days, they're positively obsessed with not missing the next big thing, and are willing to shell out huge sums of money in order to insure that they don’t.
  • But, In Truth, How Valuable Were Those Opportunities? counters Felix Salmon at Reuters: "If Blockbuster had spent $50 million on Netflix, then it would just have run out of money that much more quickly. There's no chance that Blockbuster's management would have let Netflix grow, unencumbered, in the way that it did independently," he points out. "Buying internet companies is very, very hard: even if they are set to be very successful on their own, that's no reason to believe that they will have similar success in-house."
  • Standards for Calculating Value Are Problematic, adds Steve Henn at Marketplace. In Silicon Valley, he explains, social networking companies like Twitter and Facebook trade at around 40 times their current revenue:
Apply that equation to Apple and that company's suddenly worth $2.4 trillion, instead of its current market cap of $290 billion. Do Twitter math on Exxon--$11 trillion instead of the paltry $390 billion it's actually worth today. O.K., I know there are probably 3.7 billion reasons you can't compare Twitter to Exxon Mobile. But let's just say for Kliener Perkins' $150 million investment to pay off, Twitter will have to grow exponentially for years.
  • Over-Valued Tech Start-Ups May Signal Another Bubble, suggests The Economist. For the first time since 2000, the magazine claims, "internet and technology entrepreneurs can raise seed capital with little more than a half-formed idea and a dozen PowerPoint slides." During the dotcom bubble, it was initial public offerings that were overpriced; today, start-up founders primarily make their money by selling their companies to larger ones like Cisco, Google, or Facebook. Secondary markets in shares of start-ups that have yet to go public may fuel hype about the worth of these companies, the magazine adds, though some investors claim that for every company that is funded at an above average valuation, there are many more that are financed at normal levels.
This article is from the archive of our partner The Wire.